3 Tax Strategies To Know for Investors With Over $500K
Written by
Terence Loose
Edited by
Amber Barkley
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If there’s one thing that polls lower than Congress and broccoli, it’s taxes. Virtually no one likes paying them — especially when you’ve accumulated enough wealth to find yourself in one the higher tax brackets.
Fortunately, there are solid tax-lowering strategies that don’t involve shady accountants or suspect Caribbean banks.
Direct Indexing
Index funds, which mimic an index like the S&P 500 or Nasdaq in their investments, are a simple way to diversify and reap the gains traditionally seen in these pools of stocks. But they steal a crucial tax strategy of the wealthy: tax-loss harvesting.
“Tax-loss harvesting involves taking advantage of opportunities to sell individual stock positions at a capital loss to offset existing or future capital gains,” said Franco DiLiberto, manager of wealth management services at Fairway Wealth Management.
But there is a way to have the best of both worlds through a strategy called direct indexing, he said.
“Direct indexing involves purchasing a portfolio of individual stocks that replicates the performance return of a specific benchmark index, such as the S&P 500,” said DiLiberto. “Rather than buying an exchange-traded-fund (ETF) or a mutual fund that tracks the index, with direct indexing investing, you actually own the individual stocks.”
This means that before the end of each year, you can keep winners and sell losers for a loss, reaping a tax benefit.
“For example, let’s say a direct indexing account was able to harvest tax losses of $100,000. If we assume a maximum long-term capital gains tax of 23.8%, the tax savings would be $23,800. That’s a significant tax savings,” explained DiLiberto.
He said this strategy is being offered at more firms now, with the typical minimum opening balance required ranging from $100,000 to $250,000. He added that investors need to do due diligence when choosing a firm, since strategies and fees vary.
Tax-Smart Bond Strategies
Bonds have always been a go-to investment for those nearing retirement. They offer a guaranteed return without the volatility and potential downside of the stock market. So, for older investors who can’t ride out market downturns and want guaranteed income, bonds are attractive. But gains are often reduced significantly by taxes.
Enter municipal bonds. They are fixed-income securities, so they offer a reliable return, but they are exempt from federal taxation. In some cases, they are also exempt from state and local taxes.
If they are part of a larger portfolio, with stocks, real estate and other investments, municipal bonds can be a smart move for those in higher tax brackets who want to mitigate their tax liability, said Mark Luscombe, principal analyst at Wolters Kluwer’s Tax and Accounting Division North America.
Asset Location
The strategy of asset location can be utilized by any investor, no matter their net worth, but the benefits become much more important and tax-saving for high-net worth individuals.
Basically, this strategy involves ensuring that investments open to higher taxes on returns or gains be placed in tax-advantaged accounts. At the same time, tax-efficient assets with typically lower growth potential, such as the municipal bonds mentioned above, are placed in taxable accounts.
So, for instance, you would hold stocks that you believe might outperform your other investments in accounts such as a Roth IRA or Roth 401(k), while you hold your bonds in an IRA or traditional 401(k).
In this way, you would not be taxed on the large gains of the stock — if they turn out — when taking distributions later from your Roth account, but you would also realize a current tax reduction for the money you invested in bonds with your traditional IRA or 401(k).
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